5MLD – So, How Well Do You Really Know Your Customers?

In an effort to quash money laundering, sanctions evasion and the funding of terrorist activities in the EU, regulators have overhauled the 4^th Money Laundering Directive (4MLD) with the laudable goal of increased transparency, the 5^th Money Laundering Directive (5MLD), which goes into effect January 10, 2020, seeks to pre-emptively detect questionable financial activity that may have more easily made it past know your customer (KYC) checks under 4MLD.

It is of key importance, especially in these times — post-Panama Papers — for institutions to fully understand the identities of the entities with which they are doing business and the true “beneficial owners” behind those entities.

Banks are strongly encouraged to have robust methodologies in place to detect any questionable activity well before potential issues arise.

While the changes under the upcoming 5MLD are relatively mild in comparison with those faced by banks with the implementation of 4MLD, the overarching theme of increased transparency is the significant driving force behind both sets of changes.

Here, we detail the three crucial changes that banks must be aware of as they update their KYC processes.

Critical Updates Under 5MLD

Change #1: Accessible public ownership registers

Perhaps the most significant change under 5MLD is the requirement for transparent public ownership records that make it far more difficult for criminal elements to buck the system.

This means greater public access to registers of beneficial ownership of corporations and beneficial ownership of trusts for each member state.

Criminal elements will always adapt, compelling regular updates and edifications to laws by finding ways to keep the financial system protected from misuse. 5MLD is the latest evolution in this game of cat and mouse and more stringently addresses ways in which corrupt entities have previously exploited opaque structures and offshore accounts in order to conceal the true ownership and sources of illicit proceeds.

With some requirements in common with FinCEN’s final CDD rule in the U.S., 5MLD increases the obligation of institutions to closely examine ownership structures. However, unlike the FinCEN rule, 5MLD also attempts to provide the banks with resources to make this more practicable – requiring member states to create publicly searchable ownership registers that reveal connections across member countries, providing important insights about their clients’ interests that facilitate greater transparency and help champion the fight against global money laundering.

Change #2: Intensified due diligence for high-risk countries and politically exposed persons (PEPs)

Enhanced due diligence will be applied to customers located in countries, territories, regions or principalities determined to be high-risk. The list of high-risk countries is still under construction since its first incarnation was rejected by member states. A new list is expected to be released in this summer.

Each member state will further need to produce a list of positions that qualify as “prominent public functions” that would politically expose the persons serving those functions.

These lists will facilitate screening for compliance teams, helping them to identify high-risk countries and PEPs, yet adding an additional layer of process and complexity at the same time.

Change #3: Increased regulation of virtual currencies

The peer-to-peer borderless construct that makes digital currencies so frictionless has the unfortunate effect of also being a new “path of least resistance” structure perfect for concealing criminal activity, and – as we know – much like water, illicit monies always follow the path of least resistance.

5MLD puts virtual currency exchanges under the jurisdiction of AML laws and makes them answerable to the same requirements.

Important Ways Banks Can Prepare

Evaluate existing know your customer (KYC) programs.

Institutions can begin to prepare in advance of the implementation of 5MLD by carefully evaluating the quality of existing KYC compliance programs to ensure they are rigorous enough to conform to the enhanced requirements of the coming updates.

Of key importance to consider is your institution’s ability to access beneficial ownership data and further, to confidently interpret this data and understand when it may present heightened risk or perhaps be inauthentic.

Beginning the process of reviewing procedures now, well ahead of implementation, will greatly facilitate the transition to 5MLD.

Keep on top of changing sanctions with routine KYC reviews.

Entities frequently change ownership and lists of sanctions continually change. Additionally, as sanctions regimes become more complex and nuanced, it’s becoming critical to have a deeper understanding of the less-than-obvious connections parties may have to sanctioned entities. Be certain that you are able to stay abreast of these changes by reviewing procedures and ensuring robust ongoing monitoring, greatly limiting your exposure to unseen risk.

Use technology to improve the quality of your compliance checks.

Automated workflows that assist in the ongoing, regular monitoring of client accounts can be invaluable to banks as they seek to comply with increasingly onerous KYC checks.

Keeping processes consistent conserves both time and manpower and empowers banks to more easily avoid transgressions that result in costly penalties and fines for noncompliance and, more importantly, that can leave the financial system open to abuse by criminals and terrorists.

Compliance Will Continue to Become More Challenging

Compliance will become even more complex as regulations continue to evolve in response to the ingenuity and adaptability of would-be money launderers.

In order to stay ahead of the curve, it is incumbent upon financial institutions to take seriously the responsibility of proactively putting protections in place that thwart would-be perpetrators of criminal activity, thereby preventing future transgressions and averting needless tragedies.